Today we'll look at Pushpay Holdings Limited (NZSE:PPH) and reflect on its potential as an investment. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
So, How Do We Calculate ROCE?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Pushpay Holdings:
0.22 = US$11m ÷ (US$61m - US$14m) (Based on the trailing twelve months to September 2019.)
Therefore, Pushpay Holdings has an ROCE of 22%.
Does Pushpay Holdings Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Pushpay Holdings's ROCE is meaningfully better than the 15% average in the IT industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of the industry comparison, in absolute terms, Pushpay Holdings's ROCE currently appears to be excellent.
Pushpay Holdings reported an ROCE of 22% -- better than 3 years ago, when the company didn't make a profit. That suggests the business has returned to profitability. The image below shows how Pushpay Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Pushpay Holdings.
What Are Current Liabilities, And How Do They Affect Pushpay Holdings's ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.
Pushpay Holdings has total liabilities of US$14m and total assets of US$61m. Therefore its current liabilities are equivalent to approximately 23% of its total assets. The fairly low level of current liabilities won't have much impact on the already great ROCE.
The Bottom Line On Pushpay Holdings's ROCE
With low current liabilities and a high ROCE, Pushpay Holdings could be worthy of further investigation. Pushpay Holdings looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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